Zulfiqar Hasan, Associate Professor (Finance)
Capital is one of the factors of production. The word Capital refers to be the total investment of a company of firm in money, tangible and intangible assets. Budget is the numerical statement of a plan. Allocation of fund in different working sectors of an organization is called budgeting. Budget and budgeting are used synonymously.
The examples of capital expenditure:
1. Purchase of fixed assets such as land and building, plant and machinery, good will, etc.
2. The expenditure relating to addition, expansion, improvement and alteration to the fixed assets.
3. The replacement of fixed assets.
4. Research and development project.
Concepts of Capital Budgeting
Some scholarly definitions of capital budgeting are given below:
1. The process of identifying, analyzing and selecting investment projects whose returns (cash flows) are expected to extend beyond one year.(-James C. Van Horne)
2. Capital Budgeting may be defined as the decision making process by which firms evaluate the purchase of major fixed assets including premises, machinery and equipment.
3. Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.
4. According to the definition of Charles T. Hrongreen, “capital budgeting is a long-term planning for making and financing proposed capital out lays.
5. According to the definition of G.C. Philippatos, “capital budgeting is concerned with the allocation of the firms source financial resources among the available opportunities.
6. The consideration of investment opportunities involves the comparison of the expected future streams of earnings from a project with the immediate and subsequent streams of earning from a project, with the immediate and subsequent streams of expenditure”.
7. According to the definition of Richard and Green law, “capital budgeting is acquiring inputs with long-term return”.
8. According to the definition of Lyrich, “capital budgeting consists in planning development of available capital for the purpose of maximizing the long-term profitability of the concern”.
Need and Importance of Capital Budgeting
1. Huge investments: Capital budgeting requires huge investments of funds, but the available funds are limited, therefore the firm before investing projects, plan are control its capital expenditure.
2. Long-term: Capital expenditure is long-term in nature or permanent in nature.
Therefore financial risks involved in the investment decision are more. If higher risks are involved, it needs careful planning of capital budgeting.
3. Irreversible: The capital investment decisions are irreversible, are not changed back. Once the decision is taken for purchasing a permanent asset, it is very difficult to dispose off those assets without involving huge losses.
4. Long-term effect: Capital budgeting not only reduces the cost but also increases the revenue in long-term and will bring significant changes in the profit of the company by avoiding over or more investment or under investment. Over investments leads to be unable to utilize assets or over utilization of fixed assets.
Therefore before making the investment, it is required carefully planning and analysis of the project thoroughly.
Contributor: Zulfiqar Hasan, Associate Professor (Finance).
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